Retirement Plans for Self-Employed People Share - Click this link to Share this page through email or social media Print - Click this link to Print this page Retirement Plans for Self-Employed People Are you self-employed? Did you know you have many of the same options to save for retirement on a tax-deferred basis as employees participating in company plans? Here some highlights of your retirement plan options. Simplified Employee Pension ( SEP ) Contribute as much as 25% of your net earnings from self-employment (not including contributions for yourself), up to $54,000 (for 2017; $53,000 for 2015 and 2016). Establish the plan with a simple one-page form: complete Form 5305-SEP , Simplified Employee Pension - Individual Retirement Accounts Contribution Agreement, or an IRS-approved “prototype SEP plan” offered by many mutual funds, banks and other financial institutions, and by plan administration companies; and open a SEP-IRA through a bank or other financial institution. Set up the SEP plan for a year as late as the due date (including extensions) of your income tax return for that year.

401(k) plan Make annual salary deferrals up to $18,000 (in 2015 - 2017), plus an additional $6,000 if you're 50 or older (in 2015 - 2017) either on a pre-tax basis or as designated Roth contributions . Contribute up to an additional 25% of your net earnings from self-employment for total contributions of $54,000 (for 2017; $53,000 for 2015 and 2016), including salary deferrals. Tailor your plan to allow access to your account balance through loans and hardship distributions . A one-participant 401(k) plan is sometimes referred to as a “solo-401(k),” “individual 401(k)” or “uni-401(k).” It is generally the same as other 401(k) plans, but because there are no employees other than your spouse who work for the business, it is exempt from discrimination testing.

Savings Incentive Match Plan for Employees ( SIMPLE IRA Plan ) You can put all your net earnings from self-employment in the plan: up to $12,500 (in 2015 - 2017), plus an additional $3,000 if you're 50 or older (in 2015 - 2017), plus either a 2% fixed contribution or a 3% matching contribution. Establish the plan: complete Form 5305-SIMPLE , Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) – for Use With a Designated Financial Institution, Form 5304-SIMPLE , Savings Incentive Match Plan for Employees of Small Employers (SIMPLE) - Not for Use With a Designated Financial Institution, or an IRS-approved “prototype SIMPLE IRA plan” offered by many mutual funds, banks and other financial institutions, and by plan administration companies; and open a SIMPLE IRA through a bank or another financial institution. Set up a SIMPLE IRA plan at any time January 1 through October 1.

If you became self-employed after October 1, you can set up a SIMPLE IRA plan for the year as soon as administratively feasible after your business starts. Learn more: SIMPLE IRA Tips for the Sole Proprietor Other defined contribution plans Profit-sharing plan : allows you to decide how much to contribute on an annual basis, up to 25% of compensation (not including contributions for yourself) or $54,000 (for 2017; $53,000 for 2015 and 2016). Money purchase plan : requires you to contribute a fixed percentage of your income every year, up to 25% of compensation (not including contributions for yourself), according to a formula stated in the plan. Defined benefit plans Traditional pension plan with a stated annual benefit you will receive at retirement, usually based on salary and years of service. Benefit may also be defined based on a cash balance formula in a hypothetical individual account (a cash balance plan). Maximum annual benefit can be up to $215,000 (for 2017; $210,000 for 2015 and 2016).

Contributions are calculated by an actuary based on the benefit you set and other factors (your age, expected returns on plan investments, etc.); no other annual contribution limit applies. What's a Keogh plan? Retirement plans for self-employed people were formerly referred to as “Keogh plans” after the law that first allowed unincorporated businesses to sponsor retirement plans. Since the law no longer distinguishes between corporate and other plan sponsors, the term is seldom used. Looking for prior year contribution limits? Dollar figures are subject to annual cost-of-living adjustments . Our chart and PDF file will show you contribution limits for 2017, 2016, 2015, plus earlier years back to 1998. Additional resources Pension plans legal definition of pension plans Pension plans legal definition of pension plans Related to pension plans: Retirement plans , Defined Benefit Pension Plans Pension A benefit, usually money, paid regularly to retired employees or their survivors by private businesses and federal, state, and local governments. Employers are not required to establish pension benefits but do so to attract qualified employees. The first pension plan in the United States was created by the American Express Company in 1875.

A few labor unions and state and local governments began to offer pension plans shortly thereafter, and by 1935 governments in half the states and many businesses were offering pension plans. In 1997 about half of all U.S. workers had pension plans. Employers establish pension plans by paying a certain amount of money into a pension fund. The money paid into this fund is not taxed to the employer, and it is not taxed to the employee until the employee retires and begins to collect pension benefits. The employer gives control of the pension fund to a trustee, who may invest the money in stocks and bonds and other financial endeavors to increase the fund. Some pension plans require the employee to make a small, periodic contribution to the fund. The amount of pension that a pensioner receives depends on the type of pension plan. Pension plans generally can be divided into two categories: defined benefit plans and defined contribution plans. A defined benefit plan provides a set amount of benefits to a pensioner. Under a defined contribution plan, the employer places a certain amount of money in the employee's name into the pension fund and makes no promises concerning the level of pension benefits that the employee will receive upon retirement.

Employers using defined contribution plans contribute an amount into the pension fund based on the employee's salary. As a result, higher-paid employees receive larger pensions than do lower-paid employees. The same is true for defined benefit plans: employers tend to offer larger pensions to higher-paid employees. The difference between the two types of plans is that in a defined contribution plan, the employee assumes the risk of investment failure because the funds are not insured by the federal government. Under most defined benefit plans, the employer assumes the risk that pension funds will not be available. Employees assume little risk because most funds are insured by the federal government to a certain limit. The most important issue to pensioners is the potential loss of their pension benefits. This issue is of less concern when the government is the employer because governments have access to additional funds. Such is not the case with private businesses. Before the 1970s employees did not always receive their promised pension benefits. An employee could lose his or her pension if the employer went out of business and employers could fire long-time employees just before their pensions vested to avoid paying pensions.

Citing the profound effect that pension plans have on interstate commerce and the economic security of the country, Congress enacted the Employee Retirement Income Security Act of 1974 (ERISA) (29 U.S.C.A. § 1001 et seq.) to regulate pension plans created by private businesses other than religious organizations. ERISA is a complex collection of federal statutes that take precedence over most state pension laws. The act encourages the creation of pension funds by making employer contributions to pension funds tax free. ERISA also is designed to ensure that pension funds promised to an employee will be available. It establishes rules for the vesting of pensions based on the employee's age and length of employment. Under the law an employer using a pension plan that is not funded by the employees may choose one of several methods for vesting of pensions. An employer may allow all pension benefits to become nonforfeitable once the employee has completed five years of employment. In the alternative, an employee may be guaranteed a percentage of pension funds according to length of service, with the percentage increasing as the length of service increases. An employee with three years of service is guaranteed 20 percent of the derived benefit from the employer contributions to the pension plan.

After four years the employee has a right to 40 percent of the benefits; after five years the percentage is 60; after six years the percentage is 80; and an employee who completes seven years of service becomes fully vested. An employee is always entitled to the amount of money she or he has contributed to a pension fund. Under ERISA, the fiduciaries who control the pension funds must meet certain reporting requirements. The act restricts the kinds of investments that trustees can make using pension funds. It mandates that employers make annual contributions to pension funds, and it devises formulas for setting minimum contribution levels. These formulas are created in actuarial tables based on such factors as the turnover of the participants in the plan, the life expectancy of the participants, the amount of money in pensions promised to employees, and the success of the pension fund's investments. The act authorizes criminal penalties for violators of pension laws and provides Civil Law remedies to victims of pension misuse or abuse. An employer who is delinquent in making contributions to the pension fund may have to pay penalties.

ERISA requires employers to report to pension holders significant facts regarding the pension fund, such as a summary describing in clear language how the plan works, what benefits it provides, and how such benefits can be received. The employer also must report annually to each employee the amount of benefits that have accrued and have vested, and the earliest date on which the employee's pension will vest as of the date of the report. ERISA created the Pension Benefit Guaranty Corporation (PBGC) to ensure the payment of certain benefits of pension plans. PBGC is a government corporation within the U.S. department of labor that is governed by the secretaries of labor, commerce, and treasury, and funded by premiums collected from pension plans. If an employer is unable to meet pension obligations, the PBGC may make the payments for the employer. PBGC covers only defined benefit pension plans, with the exception of church-based pension plans. Religious organizations are excepted because courts and legislatures consider church-based pensions to be an ecclesiastical matter beyond the authority of the law. An employee cannot lose pension benefits by retiring early. Under defined benefit plans, the employee may begin to receive pension benefits upon reaching the normal retirement age of 65 years.

If an employee retires before reaching age 59.5 and begins drawing from his pension, his pension payments are taxed at a 10 percent annual rate in addition to any regular income taxes. This excise tax is levied because pension funds are designed to promote security after retirement. The excise tax does not apply to a pension given to a surviving spouse when the employee dies before the pension is fully paid, even if the employee dies before reaching age 59.5. Employees who become disabled before age 59.5 do not have to pay the excise tax, nor do persons who specifically choose to receive the pension payments as an Annuity or periodically. In addition, the excise tax does not apply to pensions of employees over the age of 55 years who have separated from their employer, certain pensions paid for medical expenses, and pension payments made pursuant to certain divorce-related court orders. ERISA does not regulate pension plans with 25 or fewer participants or plans that are solely for business partners or a sole proprietor. Employees of businesses not covered by ERISA may look to state statutes governing pensions that contain regulations and requirements similar to those in ERISA. Congress refined the tax consequences of pensions in January 1996.

Under the Pension Source Act (Pub. L. No. 104-95, amending title 4 of U.S.C.A. § 114), a state that imposes income taxes may not tax pension benefits earned in the state if the pensioner is living in a state that does not impose personal Income Tax . Pensions are an attractive component of employee compensation packages. The money that the employer withholds during the working life of the employee is not taxed, and the money in a pension fund can be increased through investments. When the pensioned employee retires, she or he can ask for the entire pension in one lump sum or can take the pension as an annuity, which is a series of payments that lasts for a specified period of time. If the retiree lives long enough, she or he will receive more money than the employer originally withheld. If the pensioner dies before the pension is fully paid, her or his surviving spouse or another designated survivor may receive the remainder of the pension. A retiree who has worked at several companies may receive several pensions. Individuals who are self-employed have their own pension options.

A self-employed worker may establish a Keogh Plan , which is a type of retirement plan for self-employed workers that is comparable to a pension plan. Under a Keogh plan, the worker makes tax-free payments into a fund and receives larger payments upon retirement. An Individual Retirement Account (IRA) is another way to provide for security in retirement. An IRA is a personal retirement account that workers may establish in addition to, or instead of, a pension. Employers may establish similar personal retirement accounts for their employees. These accounts are called 401K plans, after the section of the Internal Revenue Code that authorizes them. Under a 401K plan, a worker deposits a portion of his or her gross earnings into the account to avoid income tax on that portion of the earnings. The earnings are subject to taxation when the retiring worker receives them. If the worker is in a lower tax bracket by retirement, he or she will end up paying less tax on the portion of the earnings in the IRA. Pension benefits are distinct from other retirement benefits such as Social Security and medical assistance. A pension may reduce slightly the amount of Social Security benefits that a government employee receives. Further readings Abramson, Stephen. 2003.

Financial Professional's Guide to Qualified Retirement Plans: Planning, Implementation, Operation, and Compliance. 2d ed. New York: Aspen. Driggers, Martin S., Jr. 1996. "Minister's Pension Contract Is an 'Ecclesiastical Matter' Not Reviewable by the Court." South Carolina Law Review 48 (autumn). Gregory, David. 1987. "The Scope of ERISA Preemption of State Law: A Study in Effective Federalism." University of Pittsburgh Law Review 48 (winter). Lantry, Terry L. 1996. "Retirees' Pensions Insulated from State Income Tax." Taxation for Lawyers 25 (November-December). Lewis, Barbara, and Dan Otto. 2002. "Sunset Cruise; Take Advantage of New Laws to Make Your Pensions More Valuable." Los Angeles Daily Journal (January 15). Peterson, Pete. 1996. Will America Grow Up Before It Grows Old?: How the Coming Social Security Crisis Threatens You, Your Family, and Your Country. New York: David McKay. Snyder, Michael B. 1999.

Qualified Plan Investments: Fiduciary Responsibilities and Strategies. St. Paul, Minn.: West Group. Cross-references Chapter 3: Understanding Qualified Retirement Plans - AWG Training Chapter 3: Understanding Qualified Retirement Plans Contact Us Section 1: What are Retirement Plans? Retirement plans are classified as defined benefit or defined contribution according to how benefits are determined. A defined benefit (or pension ) plan calculates benefits using a fixed formula that typically factors in final pay and service with an employer, and payments are made from a trust fund specifically dedicated to the plan. In a defined contribution plan, the payout is dependent upon both the amount of money contributed into an individual account and the performance of the investment vehicles utilized. Some types of retirement plans, such as cash balance plans, combine features of both defined benefit and defined contribution schemes. Defined contribution plan According to the Internal Revenue Code Section 414, a defined contribution plan is an employer-sponsored plan with an individual account for each participant. The accrued benefit from such a plan is solely attributable to contributions made into an individual account and investment gains on those funds, less any losses and expense charges.

The contributions are invested (e.g., in the stock market), and the returns on the investment are credited to or deducted from the individual's account. Upon retirement, the participant's account is used to provide retirement benefits, often through the purchase of an annuity . Defined contribution plan have become more widespread over recent years and are now the dominant form of plan in the private sector. The number of defined benefit plans in the US has been steadily declining, as more employers see pension funding as a financial risk they can avoid by freezing the plan and instead offering a defined contribution plan. Examples of Defined contribution plan include Individual Retirement Account (IRA), 401(k) , and profit sharing plans . In such plans, the participant is responsible for selecting the types of investments toward which the funds in the retirement plan are allocated. This may range from choosing one of a small number of pre-determined mutual funds to selecting individual stocks or other securities . Most self-directed retirement plans are characterized by certain tax advantages . The funds in such plans may not be withdrawn without penalty until the investor reaches retirement age, which is typically 59.5 years of age. Money contributed can be from employee salary deferrals, employer contributions, or employer matching contributions.

Defined contribution plan are subject to IRS section 415 limits on how much can be contributed. As of 2012, the total deferral amount including the employee and employer contribution is the lesser of $50,000 or 100% of compensation. The employee-only amount is $17,000 for 2012, but a plan can permit participants who are age 50 or older to make "catch-up" contributions of up to an additional $5,500. Defined benefit plans Commonly referred to as a pension in the US, a defined benefit plan pays benefits from a trust fund using a specific formula set forth by the plan sponsor. In other words, the plan defines a benefitthat will be paid upon retirement. The statutory definition of defined benefit encompasses all pension plans that are not defined contribution and therefore do not have individual accounts.

While this catch-all definition has been interpreted by the courts to capture some hybrid pension plans like cash balance (CB) plans and pension equity plans (PEP), most pension plans offered by large businesses or government agencies are final average pay (FAP) plans, under which the monthly benefit is equal to the number of years worked multiplied by the member's salary at retirement multiplied by a factor known as the accrual rate. At a minimum, benefits are payable in normal form as a Single Life Annuity (SLA) for single participants or as a Qualified Joint and Survivor Annuity (QJSA) for married participants. Both normal forms are paid at Normal Retirement Age (usually 65) and may be actuarially adjusted for early or late commencement. Other optional forms of payment, such as lump sum distributions, may be available but are not required. The cash balance plan typically offers a lump sum at and often before normal retirement age. However, as is the case with all defined benefit plans, a cash balance plan must also provide the option of receiving the benefit as a life annuity . The amount of the annuity benefit must be definitely determinable as per IRS regulation 1.412-1.

Defined benefit plans may be either funded or unfunded. In a funded plan, contributions from the employer and participants are invested into a trust fund dedicated solely to paying benefits to retirees under a given plan. The future returns on the investments and the future benefits to be paid are not known in advance, so there is no guarantee that a given level of contributions will meet future obligations. Therefore, fund assets and liabilities are regularly reviewed by an actuary in a process known as valuation. A defined benefit plan is required to maintain adequate funding if it is to remain qualified . In an unfunded plan, no funds are set aside for the specific purpose of paying benefits. The benefits to be paid are met immediately by contributions to the plan or by general assets. Most government-run retirement plans, including Social Security , are unfunded, with benefits being paid directly out of current taxes and Social Security contributions. Most nonqualified plans are also unfunded. Section 2: Definition of Qualified Retirement Plans Qualified retirement plans Qualified plans receive favorable tax treatment and are regulated by ERISA . The technical definition of qualified does not agree with the commonly used distinction. For example, 403(b) plans are not considered qualified plans, but are treated and taxed almost identically.

The term qualified has special meaning regarding defined benefit plans. The IRS defines strict requirements a plan must meet in order to receive favorable tax treatment, including: A plan must offer life annuities in the form of a Single Life Annuity (SLA) and a Qualified Joint & Survivor Annuity (QJSA). A plan must maintain sufficient funding levels. A plan must be administered according to the plan document. Benefits are required to commence at retirement age (usually age 65 if no longer working, or age 70 1/2 if still employed). Once earned, benefits may not be forfeited. A plan may not discriminate in favor of highly-compensated employees. A plan must be insured by the PBGC . Failure to meet IRS requirements can lead to plan disqualification, which carries with it enormous tax consequences. Section 3: History of the 401k (403b, etc.) What is a 401k? A 401(k) is a type of retirement savings account in the United States, which takes its name from subsection 401(k) of the Internal Revenue Code (Title 26 of the United States Code).

401(k) are "defined contribution plans" with annual contributions limited (currently to $17,000). [1] Contributions are "tax-deferred" -- deducted from paychecks before taxes and then taxed when a withdrawal is made from the 401(k) account. Depending on the employer's program a portion of the employee's contribution may be matched by the employer. ( Click here for in-depth details on how the 401k plan operate s - some questions will be on this chapter test.) Click this link to read this article: "Lack of Retirement Plans" The History of the 401k? Forget about rescuing banks or unfreezing credit markets. The question on most minds amid the recent market chaos: What does this mean for my 401(k)? With some $3 trillion invested, these plans are the most popular retirement-savings vehicle in the U.S.--and account for a big chunk of the $2 trillion the crisis has wiped from American nest eggs. The 401(k) plan--named for a section of the Internal Revenue Code--came about thanks to a 1978 congressional provision intended to offer taxpayers breaks on deferred income.

In 1980, while trying to streamline a client's profit-sharing plan, benefits consultant Ted Benna realized that the code could be used to create an easy, tax-friendly vehicle for employees to save for retirement. The client passed, but the idea took off: there are now more than 65 million 401(k) accounts, which allow participants to invest in stocks and bonds, often with matching funds from employers--all at a lower cost than the pension plans that 401(k)s replaced. The accounts helped spark a financial-industry boom, funneling billions from under retirement savers' mattresses into mutual funds and the stock market. But 401(k)s didn't yield smarter investors. In the 1990s, employees at some fast-growing companies kept up to 90% of their 401(k)s in company stock. When Enron and WorldCom tanked in 2001 and '02, they each took more than $800 million in savings with them, prompting landmark lawsuits. The current meltdown has skimmed about 20% from 401(k)s since 2007 and ignited debate over their retirement-income reliability.

"Unlike Wall Street executives, American families don't have a golden parachute to fall back on," said California Representative George Miller at an Oct. 7 hearing on retirement savings. At least they still have mattresses. Section 4: Other Types of Plans SIMPLE IRAs A SIMPLE IRA is a type of Individual Retirement Account (IRA) that is provided by an employer. It is similar to a 401(k) but offers simpler and less costly administration rules. Like a 401(k) plan, the SIMPLE IRA is funded by a pre-tax salary reduction. However, contribution limits for SIMPLE plans are lower than for most other types of employer-provided retirement plans. SEP IRAs A Simplified Employee Pension Individual Retirement Account, or SEP IRA , is a variation of the Individual Retirement Account. SEP IRAs are adopted by business owners to provide retirement benefits for the business owners and their employees. There are no significant administration costs for self-employed person with no employees. If the self-employed person does have employees, all employees must receive the same benefits under a SEP plan. Since SEP accounts are treated as IRAs, funds can be invested the same way as any other IRA.

Keogh or HR10 Plans Keogh plans are full-fledged pension plans for the self-employed. Named for U.S. Representative Eugene James Keogh of New York, they are sometimes called HR10 plans. Nonqualified plans Plans that do not meet the guidelines required to receive favorable tax treatment are considered nonqualified and are exempt from the restrictions placed on qualified plans. They are typically used to provide additional benefits to key or highly-paid employees, such as executives and officers. Examples include SERP (Supplemental Executive Retirement Plans) and 457(f) plans . Create a free website Retirement Accounts Asset Protection Attorney | The Presser Law Firm, P.A. Join Our Complimentary Asset Protection Newsletter Retirement Planning: Retirement, Pension and Profit Sharing Plans Retirement Accounts (IRAs), pension plans and profit sharing plans are designed to prepare individuals for retirement and to defer income taxation. More and more individuals and business owners direct significant wealth into IRA accounts and other tax qualified retirement plans. Most states allow these type assets to be creditor exempt. One of the most highly used tools for retirement planning is the Individual Retirement Arrangement (IRA). The IRA is a form of retirement plan that provides tax and other advantages for retirement savings in the United States.

IRA's come in various types including; Traditional IRA, Roth IRA, SEP IRA, Simple IRA and Self-Directed IRA. Other popular retirement planning tools plans that may be exempt (depending on state exemption statutes) include pension plans, profit sharing, 401(k) plans, and Keogh Plans. Pension: A pension is a contract for a fixed sum to be paid regularly to a person, typically following Retirement plans may be set up by employers, insurance companies, the government or other institutions such as employer associations or trade unions. Profit Sharing Plan: This includes any incentive plans provided by businesses to employees for direct or indirect payments based on a company's profitability or other pre-determined sharing rule. These can also be added to retirement plans – and are often used in combination with 401(k) Plans. 401K Retirement Contribution Plan: A 401(k) plan is defined as contribution plans with annual contributions limited (currently to $17,000). Contributions are "tax-deferred"—deducted from paychecks before taxes and then taxed when a withdrawal is made from the 401(k) account later on.

Depending on the employer's program a portion of the employee's contribution may be matched by the employer. Traditional "Regular" IRA: The Traditional IRA is held at a custodian institution such as a bank or brokerage, and may be invested in anything that the custodian allows. The only criterion for being eligible to contribute to a Traditional IRA is sufficient income to make the contribution, however, the Traditional IRA has more restrictions on withdrawals. Roth IRA: The Roth IRA is a special type of retirement plan under US law that is generally not taxed, provided certain conditions are met. The Roth IRA's principal difference from most other tax advantaged retirement plans is that, rather than granting a tax break for money placed into the plan, the tax break is granted on the money withdrawn from the plan during retirement. The Roth IRA's principal difference from most other tax advantaged retirement plans is that, rather than granting a tax break for money placed into the plan, the tax break is granted on the money withdrawn from the plan during retirement. Also, there are fewer restrictions on the investments that can be made in the plan than other similar type plans.

SEP IRA: Simplified Employee Pension Individual Retirement Arrangements (SEP IRA) are usually adopted by business owners to provide retirement benefits for themselves and their employees. The funds within the SEP accounts can be invested in the same way as any other IRA. SELF DIRECTED IRA A Self-Directed Individual Retirement Arrangement is an IRA where a custodian or trustee holds the IRA assets on behalf of the IRA owner. The trustee/custodian will usually maintain all assets and keep all paperwork regarding them; including filing IRS reports and issuing client statements. The trustee/custodian will also help the IRA owner understand the rules and regulations of investing and offer them various investment options (stocks, bonds, and mutual funds usually – with other type investments sometimes). SIMPLE IRA Savings Incentive Match Plan for Employees Individual Retirement Account (SIMPLE IRA) is a tax-deferred employer provided retirement plans that allows employees to set aside money they earn. The money that is set aside is allowed to be invested– so that the employee can grow the SIMPLE IRA for their retirement. SIMPLE IRAs bear similarities to the more well known, 401K retirement plans. Keogh Plan: Keogh Plans are retirement plans for self employed people and small businesses.

Funds in the plan can be invested (in stocks, bonds, mutual funds, and other acceptable financial outlets). The main benefit of this plan over others is that it has a higher contribution limit for some individuals. YES, YOU CAN LOSE EVERYTHING! You may think that your wealth is safe and that you don't need protection. But don't delude yourself and accept reality — for every 60 minutes you spend making money, spend 60 seconds thinking about how to protect it! Domestic and International Asset Protection Attorney | Contact Us | Site Map | Firm Pledge | Privacy Policy The information on this website is for general information purposes only. Nothing on this site should be taken as legal advice for any individual case or situation. The Presser Law Firm, P.A. is not a tax advisor, and has not and will not provide you with any tax or compliance related advice with respect to our services, you will need to seek independent professional tax advice. All entities created by The Presser Law Firm, P.A.

are intended to be tax neutral and that any income earned, whether it is from a domestic or international entity, is reportable in the year earned regardless of whether such funds are withdrawn from the entity or repatriated in the case of international entities. Further, this information is not intended to create, and receipt or viewing does not constitute, an attorney-client relationship. The Presser Law Firm, P.A. - Asset Protection Attorney Located at 6199 N. Federal Highway Boca Raton, FL 33487. View Map Phone: (561) 953-1050 Pension (United States) legal definition of Pension (United States) Pension (United States) legal definition of Pension (United States) Also found in: Dictionary , Thesaurus , Medical , Financial , Encyclopedia , Wikipedia . Pension A benefit, usually money, paid regularly to retired employees or their survivors by private businesses and federal, state, and local governments. Employers are not required to establish pension benefits but do so to attract qualified employees. The first pension plan in the United States was created by the American Express Company in 1875.

A few labor unions and state and local governments began to offer pension plans shortly thereafter, and by 1935 governments in half the states and many businesses were offering pension plans. In 1997 about half of all U.S. workers had pension plans. Employers establish pension plans by paying a certain amount of money into a pension fund. The money paid into this fund is not taxed to the employer, and it is not taxed to the employee until the employee retires and begins to collect pension benefits. The employer gives control of the pension fund to a trustee, who may invest the money in stocks and bonds and other financial endeavors to increase the fund. Some pension plans require the employee to make a small, periodic contribution to the fund. The amount of pension that a pensioner receives depends on the type of pension plan. Pension plans generally can be divided into two categories: defined benefit plans and defined contribution plans. A defined benefit plan provides a set amount of benefits to a pensioner. Under a defined contribution plan, the employer places a certain amount of money in the employee's name into the pension fund and makes no promises concerning the level of pension benefits that the employee will receive upon retirement.

Employers using defined contribution plans contribute an amount into the pension fund based on the employee's salary. As a result, higher-paid employees receive larger pensions than do lower-paid employees. The same is true for defined benefit plans: employers tend to offer larger pensions to higher-paid employees. The difference between the two types of plans is that in a defined contribution plan, the employee assumes the risk of investment failure because the funds are not insured by the federal government. Under most defined benefit plans, the employer assumes the risk that pension funds will not be available. Employees assume little risk because most funds are insured by the federal government to a certain limit. The most important issue to pensioners is the potential loss of their pension benefits. This issue is of less concern when the government is the employer because governments have access to additional funds. Such is not the case with private businesses. Before the 1970s employees did not always receive their promised pension benefits. An employee could lose his or her pension if the employer went out of business and employers could fire long-time employees just before their pensions vested to avoid paying pensions.

Citing the profound effect that pension plans have on interstate commerce and the economic security of the country, Congress enacted the Employee Retirement Income Security Act of 1974 (ERISA) (29 U.S.C.A. § 1001 et seq.) to regulate pension plans created by private businesses other than religious organizations. ERISA is a complex collection of federal statutes that take precedence over most state pension laws. The act encourages the creation of pension funds by making employer contributions to pension funds tax free. ERISA also is designed to ensure that pension funds promised to an employee will be available. It establishes rules for the vesting of pensions based on the employee's age and length of employment. Under the law an employer using a pension plan that is not funded by the employees may choose one of several methods for vesting of pensions. An employer may allow all pension benefits to become nonforfeitable once the employee has completed five years of employment. In the alternative, an employee may be guaranteed a percentage of pension funds according to length of service, with the percentage increasing as the length of service increases. An employee with three years of service is guaranteed 20 percent of the derived benefit from the employer contributions to the pension plan.

After four years the employee has a right to 40 percent of the benefits; after five years the percentage is 60; after six years the percentage is 80; and an employee who completes seven years of service becomes fully vested. An employee is always entitled to the amount of money she or he has contributed to a pension fund. Under ERISA, the fiduciaries who control the pension funds must meet certain reporting requirements. The act restricts the kinds of investments that trustees can make using pension funds. It mandates that employers make annual contributions to pension funds, and it devises formulas for setting minimum contribution levels. These formulas are created in actuarial tables based on such factors as the turnover of the participants in the plan, the life expectancy of the participants, the amount of money in pensions promised to employees, and the success of the pension fund's investments. The act authorizes criminal penalties for violators of pension laws and provides Civil Law remedies to victims of pension misuse or abuse. An employer who is delinquent in making contributions to the pension fund may have to pay penalties.

ERISA requires employers to report to pension holders significant facts regarding the pension fund, such as a summary describing in clear language how the plan works, what benefits it provides, and how such benefits can be received. The employer also must report annually to each employee the amount of benefits that have accrued and have vested, and the earliest date on which the employee's pension will vest as of the date of the report. ERISA created the Pension Benefit Guaranty Corporation (PBGC) to ensure the payment of certain benefits of pension plans. PBGC is a government corporation within the U.S. department of labor that is governed by the secretaries of labor, commerce, and treasury, and funded by premiums collected from pension plans. If an employer is unable to meet pension obligations, the PBGC may make the payments for the employer. PBGC covers only defined benefit pension plans, with the exception of church-based pension plans. Religious organizations are excepted because courts and legislatures consider church-based pensions to be an ecclesiastical matter beyond the authority of the law. An employee cannot lose pension benefits by retiring early. Under defined benefit plans, the employee may begin to receive pension benefits upon reaching the normal retirement age of 65 years.

If an employee retires before reaching age 59.5 and begins drawing from his pension, his pension payments are taxed at a 10 percent annual rate in addition to any regular income taxes. This excise tax is levied because pension funds are designed to promote security after retirement. The excise tax does not apply to a pension given to a surviving spouse when the employee dies before the pension is fully paid, even if the employee dies before reaching age 59.5. Employees who become disabled before age 59.5 do not have to pay the excise tax, nor do persons who specifically choose to receive the pension payments as an Annuity or periodically. In addition, the excise tax does not apply to pensions of employees over the age of 55 years who have separated from their employer, certain pensions paid for medical expenses, and pension payments made pursuant to certain divorce-related court orders. ERISA does not regulate pension plans with 25 or fewer participants or plans that are solely for business partners or a sole proprietor. Employees of businesses not covered by ERISA may look to state statutes governing pensions that contain regulations and requirements similar to those in ERISA. Congress refined the tax consequences of pensions in January 1996.

Under the Pension Source Act (Pub. L. No. 104-95, amending title 4 of U.S.C.A. § 114), a state that imposes income taxes may not tax pension benefits earned in the state if the pensioner is living in a state that does not impose personal Income Tax . Pensions are an attractive component of employee compensation packages. The money that the employer withholds during the working life of the employee is not taxed, and the money in a pension fund can be increased through investments. When the pensioned employee retires, she or he can ask for the entire pension in one lump sum or can take the pension as an annuity, which is a series of payments that lasts for a specified period of time. If the retiree lives long enough, she or he will receive more money than the employer originally withheld. If the pensioner dies before the pension is fully paid, her or his surviving spouse or another designated survivor may receive the remainder of the pension. A retiree who has worked at several companies may receive several pensions. Individuals who are self-employed have their own pension options.

A self-employed worker may establish a Keogh Plan , which is a type of retirement plan for self-employed workers that is comparable to a pension plan. Under a Keogh plan, the worker makes tax-free payments into a fund and receives larger payments upon retirement. An Individual Retirement Account (IRA) is another way to provide for security in retirement. An IRA is a personal retirement account that workers may establish in addition to, or instead of, a pension. Employers may establish similar personal retirement accounts for their employees. These accounts are called 401K plans, after the section of the Internal Revenue Code that authorizes them. Under a 401K plan, a worker deposits a portion of his or her gross earnings into the account to avoid income tax on that portion of the earnings. The earnings are subject to taxation when the retiring worker receives them. If the worker is in a lower tax bracket by retirement, he or she will end up paying less tax on the portion of the earnings in the IRA. Pension benefits are distinct from other retirement benefits such as Social Security and medical assistance. A pension may reduce slightly the amount of Social Security benefits that a government employee receives. Further readings Abramson, Stephen. 2003.

Financial Professional's Guide to Qualified Retirement Plans: Planning, Implementation, Operation, and Compliance. 2d ed. New York: Aspen. Driggers, Martin S., Jr. 1996. "Minister's Pension Contract Is an 'Ecclesiastical Matter' Not Reviewable by the Court." South Carolina Law Review 48 (autumn). Gregory, David. 1987. "The Scope of ERISA Preemption of State Law: A Study in Effective Federalism." University of Pittsburgh Law Review 48 (winter). Lantry, Terry L. 1996. "Retirees' Pensions Insulated from State Income Tax." Taxation for Lawyers 25 (November-December). Lewis, Barbara, and Dan Otto. 2002. "Sunset Cruise; Take Advantage of New Laws to Make Your Pensions More Valuable." Los Angeles Daily Journal (January 15). Peterson, Pete. 1996. Will America Grow Up Before It Grows Old?: How the Coming Social Security Crisis Threatens You, Your Family, and Your Country. New York: David McKay. Snyder, Michael B. 1999.

Qualified Plan Investments: Fiduciary Responsibilities and Strategies. St. Paul, Minn.: West Group. Cross-references

Question: In the US, Keogh Plans are full-fledged pension plans for small businesses and what other type of people?
Answer: Self-employed